Personal Finance 101: A Practical Guide For Managing Money
If you’re reading this, it’s likely you’re ready to get serious about personal finance. Let me take this moment to say…
You are doing something to change your life for the better and that deserves recognition. Before we begin, I’d like to give you a little background on me, and about what you’ll learn in this guide.
Personal finance can be overwhelming when you start digging into it, so we’ll focus on the basic concepts you should know. While it’s not all going to be a walk in the park, I’ll highlight simple, actionable things you can do starting today that will provide you huge results in the future.
- What is personal finance?
- Personal finance 101
- Get organized, informed and in control
- Focus on becoming debt-free
- Protect yourself and your family
- Get Insured
- Investing for the future
- Financial independence and early retirement
- Start developing a money management system
- Tips, myths, rules of thumb, and common money mistakes
- Favorite Personal Finance and Self Help Books
- Personal finance blogs, podcasts, and subreddits
What is personal finance?
Personal finance encompasses everything to do with how you manage your money. It includes budgeting, saving, investing, retirement planning, and more. Every adult should have a basic understanding of personal finance since it impacts so many aspects of your life. The great thing is that it’s not a very complicated subject, it just takes dedication to do learn the right habits.
Personal finance 101
- Get organized, informed, and in control
- Focus on becoming debt-free
- Protect yourself and your family
- Begin Investing for your future
- Pursue financial independence and/or early retirement
Get organized, informed and in control
Without organization, personal finances feel like a juggling act where you are reacting to the latest crisis. These constant, out of control fire drills will leave you emotionally and physically exhausted. Getting organized is the key to changing that. If you don’t know where your money is coming and going, how can you make sure it’s doing what you want?
Every month, your hard-earned money may be going towards paying for dinners from months or years ago and paying for student loans you wracked up while earning a degree that may not be living up to your expectations. Are you angry about it? I know I was. It’s time to decide enough is enough!
Perform a self-audit
Success with personal finance requires a strong foundation to build upon which means you need to know what’s going on with your money right now. This will enable you to make more intentional decisions on where it’s coming from and going to. Here’s is a simple exercise you can do right now to get organized.
What You Need To Do It: You monthly bank and credit card statements, and something to write with.
- First, list what you get paid this month, and when you expect to receive it. If it fluctuates, list the average amount.
- Second, list out your monthly payments and the dates they are due
- Third, keep the list somewhere you can see it. Whenever you receive the income or make the payment put a check by it.
- Finally, rinse and repeat monthly
Income or Payment
Credit Card Payment
Your list should look something like the above, though probably a bit longer. Doing this exercise every month will cause you to be more engaged and aware of when money is coming and when it’s due. That knowledge can greatly reduce the amount of mental energy you expend juggling these in your head.
Create a budget
So now that you know what money is coming in and what monthly payments you have, you can create a monthly budget. This puts you in control by tracking every dollar coming in and deciding where every dollar is going before the money is spent.
Sounds like a lot of work, right? I’m not going to lie. This takes commitment. But it works 100% of the time. How much time and emotional energy do you already spend juggling paychecks and bills? All you’re doing is re-focusing that energy to the right place.
Once you have your budget, you’ll have a detailed account of your income and expenses, which will help you to understand your monthly cash flow. This is huge.
Personal finance revolves around managing cash flow. It’s what enables you to pay down debt, save for emergencies, and invest for your future. If you’re struggling to stay on track with your budget, it’s worth considering using the cash envelope system popularized by Dave Ramsey.
Make your budget and financial goals visible
A big part of being successful with budgeting and reaching your financial goals is to maintain visibility. This can be as simple as just having a place to write stuff down.
Don’t underestimate the power of writing your budget on a whiteboard and crossing items off it you go.
It will keep you focused, motivated, and organized.
Honestly, it might be the best $25 investment you ever make.
Know your credit score and how it’s calculated
Your credit score is a number, usually between 300-850 (in general, the higher your score the better) that represents to lenders your level of creditworthiness. Banks use this three-digit number to decide whether to lend you money (say, for a car or a house) and on what terms.
You may be able to get a loan even if you have a low score—but you’ll probably be faced with abnormally high-interest rates or be required to provide collateral. Potential employers and landlords can also use your score to decide whether you’d be a safe bet as an employee or tenant.
There are three primary sources for getting your credit score; Equifax, Experian, and Transunion. While they won’t reveal what formulas they use for calculating your score, the primary factors are:
- How much revolving debt do you already have (i.e. credit cards, lines of credit) and how much of it is being utilized?
- How much non-revolving debt (i.e. car loans, personal loans, student loans, mortgages, etc) do you have?
- What’s your payment history and delinquency rate?
- How long you have been borrowing money?
It’s recommended you check your credit score once every few months. Luckily there are several different ways to check your credit score fast and for free. There are also a ton of apps out there that keep you updated like Credit Karma, CreditWise, and Credit Sesame. Most credit card companies also offer you free access to your credit score either in their apps or on your statements.
Save a $1000 resiliency fund
Your resiliency fund a small amount of cash, around $1000, set aside in a separate saving account linked to the primary checking that provides you some buffer against minor emergencies. This is extremely useful when you are focusing on paying down debt since setbacks can create a domino effect. The resiliency fund stops the dominos from falling.
This fund acts as a safety net while you are learning to manage your money better. Something will go wrong, like an issue with your car. The small cash reserver you’ve set up allows for some wiggle room to fix your car without having to miss a different payment.
The important thing to remember with your resiliency fund is that you need to replenish it ASAP with whatever cash flow remains at the end of the month AFTER all your other bills are paid. Think of it as you giving yourself a helping hand when the unexpected happens.
Start paying yourself first
The usual pattern for most of us is…
- You get your paycheck every other week
- Life happens, bills become due, something breaks
- No more money until the next payday
This makes it very difficult to start making any traction since all your money is gone by the end of the month. But here’s the thing, money tends to get spent whether you want it to or not, so make your own goals the priority. This becomes much easier once you start budgeting since you can tell just how much money you’ll have at the end of the month before the months begin. Use this insight to start paying yourself first and begin taking control of your finances.
Focus on becoming debt-free
It’s time to get those monkeys off your back for good! Getting out of debt is probably one of the more difficult efforts you’ll undertake in your life. It’s also one of the most rewarding. Now we’ll talk about the strategies you can use to make this easier on yourself. Once you’ve created a budget, the next decision is what strategy you’ll use to pay down your debt.
There are two commonly used approaches people called “The Debt Snowball” and “The Debt Avalanche”, which we’ll discuss in more detail below.
The debt snowball
This strategy has become increasingly popular thanks to Dave Ramsey. The general idea is to list all of your outstanding debt from smallest to largest balance, and then focus all of your available cash flow on the smallest debt. When that one is paid off, the money you were using to pay that debt is added to your monthly cash flow, enabling you to go after the next smallest debt. Each time a debt is paid off, your “snowball” of cash flow grows and grows.
- The focus on smaller debts creates quick wins
- Has a motivating psychological benefit
- You pay more interest over time
The debt avalanche
In this approach, you list your debt from highest to lowest APR, and then focus your available cash flow on the highest interest rate loan. When that’s paid off, you add the payment amount to your available cash flow and tackle the loan with the next highest APR.
- You pay less overall interest
- It takes longer to start seeing results
- Potentially demotivating
Attack your debt and burn the bridges
You are now focused on doing just one thing…paying off ALL your consumer debt.
This is by far the hardest part and where many people get frustrated and quit.
Military commanders throughout history have ordered their troops to set fire to the bridges and boats behind them as they move into enemy territory.
This is done so they won’t have the option of retreat when it gets tough. I love this concept as it relates to personal finance.
Most folks get into financial trouble by accumulating debt over time–a car loan, student loan repayment plans, a new credit card. They slowly add up, and before you know it, you find yourself in the middle of a financial war zone.
You’ll never achieve financial freedom if you fall back on these same habits each time life throws you a curveball.
Persevere! Don’t Quit!
Find the “why” that motivates your
Make sure you have a clear understanding of what’s your motivation for transforming your finances. It could be your health, your family, your future, etc. Whatever it is, write it down somewhere visible as a daily reminder to keep you motivated.
To truly be successful you will need to find your motivating” why”. What’s the real reason you’re doing this? Your health? Your family? Whatever it is, make sure you know why you’re doing this. It will come in handy when things start to get really tough.
You’ll also need to hold yourself accountable. Try sharing your successes with others…let people know what you’re doing. Some may find it annoying, but others will be supportive and motivating. If you need some focused support, consider trying 1:1 financial coaching. The key is to create accountability.
Protect yourself and your family
Stuff happens. It doesn’t matter what you do…unexpected expenses will come up. All you can control is how you react in real-time. How you protect yourself now can make all difference how you react in the future. This protection can come in many forms, like:
- Creating an emergency fund for when times get tough
- Getting life insurance in place to protect your family when you’re no longer able
- Drafting a will to make sure everything is properly taken care of in case something happens to you
Save up for an emergency fund with 6 months of living expenses
The second savings account you’ll set up is your emergency fund.
A popular personal finance rule of thumb is that your emergency fund should cover about six months of living expenses e.g. a substantial emergency, like a job loss.
Don’t plan on building your emergency fund out until you are fully out of debt, excluding your mortgage.
All your available cash flow should go to attack your debts.
You need to stay motivated. Too much cushion can make you complacent and comfortable. In the meanwhile, you can use your resiliency fund if you need it.
If you have a family that depends on your income, you need life insurance
The primary purpose of life insurance is to replace your income when you have a family that is dependent on it. If you are single without children, you really don’t need to worry about this. If you have a spouse and/or children that are dependent on your income, I recommend you get a Term life policy, that insures you for around 10x your annual income.
What is term life insurance?
Term life insurance is a time-bound insurance policy e.g. 10-year term, 20-year term, etc. There is no savings account included, so it’s similar to traditional insurance product like car insurance.
You pay a premium, that’s usually between $25-$100 a month, which should provide most folks with a policy that covers 8-10x their income. This coverage is in place through the “term” of the policy.
What is whole life insurance?
As the name implies, this is a policy that insures you for your whole life. What really sets it apart from term life is that it considered insurance AND a way to invest for retirement. That sounds like a win-win, except they tend to have higher monthly costs, high management fees, sub-standard returns, and can be very confusing and difficult to get out of.
That’s not to say there aren’t times it may make sense, but 99% of the time you are better off getting term life and save for retirement in more traditional ways e.g. Roth IRA’s and 401K’s.
Wills and estate planning
If you have a family that is dependent on you, then you should have a will. It doesn’t have to be complicated, and you don’t have to have a lot of money to benefit from having one. The main benefit is that there is a clear set of instructions from you on how your family should be taken care of when you pass.
Without a will, your family could end up fighting about who gets what, in which case the courts have to weigh in which can be a timely and expensive activity. Short and simple, death is difficult enough as it. You love your family. Don’t let your passing be even harder on them.
Investing for the future
When it comes to investing, the prevailing philosophy is you should start the sooner rather than later so you have the benefit of time on your side. The reason this is so important is due to the concept of compound interest, which means you earn interest on your interest. Over time this can add up to huge gains, without much principal.
All that said, I would recommend you first focus on paying off all your debt first, second build an emergency fund first….AND THEN start investing. Note: one exception is if your company provides a match with your 401k. In that case, I’d have a hard time leaving that money on the table. The rest should go to paying off debt.
Once you do begin investing, below is a popular framework used for prioritizing where to invest:
- First, put 15-20% of your income into a tax-advantaged retirement account
- Then, put some money into a 529 College saving account (if you have kids)
- Third, identify what your long-term goals are outside of retirement
- Finally, use those goals to determine which investment vehicles you should pursue
Being debt-free puts you in a huge position of strength to save for retirement. All of the cash flow you had been using to pay down principal can now go to growing your wealth. Because of that, you’ll very quickly start to pile up cash.
So what do you do with that money? You put it into an investment account that is designed for retirement investing. This way you aren’t dependent on only social security when you’re older.
- 401k: Employee sponsored programs that often include a match from the employer. That’s free money! The other big benefit is that you can contribute up to $18.5k, which is huge. The main downside is that they typically have a limited range of funds you can contribute to, so you sometimes end up with high fees and expenses.
- 403b, 457, and Thrift Savings Plan: Non-profit, government and military-sponsored retirement savings account. They are similar in a lot of ways to a 401k, but each has its own nuances regarding the contribution limits and the types of funds you’ll find available.
- IRA: Non-employee sponsored retirement investment accounts that you can find at most brokers. They typically have a contribution limit of around $5.5k, which increases a little bit as you get older. The big benefit here is that you can typically find a wide range of funds to invest in, which gives you a lot more options for diversification.
What’s A Roth? Traditional?
When it comes to retirement accounts, there are two primary ways that contributions are treated as it relates to taxes. Below is a quick summary of the primary difference between them.
- Traditional retirement account: With a traditional retirement account, your contribution is PRE-TAX, which means you can claim the contribution as a deduction during that tax year, but when you withdraw it during retirement, you’ll need to pay taxes on the whole thing.
- Roth retirement account: With a Roth IRA (or 401k) your contribution is POST-TAX, which means you pay all the taxes on the money in the year that you contribute BUT, when you withdraw it during retirement, the growth is now tax-free. There are a ton of nuances to each of these regarding income amounts, age, early withdraw, etc, which will play into someone’s decision. There are also various tax optimization strategies that someone can explore as well to find out what’s right for them.
The buy and hold strategy
One mistake folks make when investing, is to actively try to time the market. They do this by trying to buy low and sell high. The problem is that due to market volatility, it’s very difficult to tell what’s “high” and what’s “low”. There are folks who make a living doing this, but for the most case, they aren’t us 🙂
For the rest of us, there is the “buy and hold” strategy. What this means is that once you’ve identified an investment appropriate for your needs, stick with it. I’ll monitor it to make sure it’s generally doing well, but I won’t sell it unless something dramatic happens to it or I need to adjust my portfolio mix.
While I love personal finance, I don’t love researching the stock market, which means I’m not going to be successful in trying to time the market.
Goal-based investment funds
Once you’ve begun investing for retirement, you may find yourself in a position where you have additional money to invest. Rather than go at it haphazardly, I recommend you make sure you know what your goal is for the investment. Once you know what your financial goals are, figuring out the strategy to invest for it becomes a lot easier.
- Want to save a down payment for a house? You probably want to an investment that is more short-term focused and less risky. Try using a robo advisor with a low-risk threshold.
- It would be nice to retire right early? Maybe you start looking at passive, income replacing investments like rental houses.
- Kids’ college tuition? Wouldn’t it be nice for them to not be a student debt statistic? How about a 529?
Saving for college
Student loans have also become an increasingly painful problem. One alternative is to begin saving for college when your children are young using a 529 investment account, which are financial services designed for saving for a child’s education.
There are a ton of options out there since most states have their own flavors of them.
The good thing is you aren’t forced to consider only your states option, though you may get some of the local tax benefits if you do.
These educational savings accounts typically function like a Roth, where the money is contributed after it’s taxed. That means the money you take out is tax-free as long as you are using it for educational purposes covered by the program, like tuition and room & board. Some actually allow you to withdraw funds for non-educational purposes if your child ends up with scholarships.
The main downside is if you don’t end up using the funds for college, you will have to pay taxes on the growth and potentially some fees depending on the timing of the withdraw.
College tuition is going to keep going up. The good news is you can start saving now, and the growth can pay for the majority of it!
Financial independence and early retirement
For some of us, the ultimate goal is to be financially secure enough that we can retire early if we so desire. Typically this is done by aggressively saving and investing, while also creating passive income streams that can replace your paycheck. There are lots of different paths to financial independence, but most often they include some combinations of:
- Investing in cash-flow producing rental properties
- Establishing a dividend-focused stock portfolio
- Launching a “passive” business-like becoming an online retailer or blogger. These businesses are traditionally very front-loaded in terms of the effort required to get them going. The primary goal of them though is to eventually get to a place where the business runs itself with little ongoing upkeep.
“The question isn’t at what age I want to retire, it’s at what income.”George Foreman
Start developing a money management system
A well-developed money management system should function as a well-balanced ecosystem, with different pieces that all serve a specific purpose and work in coordination with each other. It should incorporate elements of budgeting, saving, and investing, all working in harmony. At the highest level, money all flows in and out from the exact same place, my primary checking account. From there it flows through different levels, each with their own purpose and benefit.
Here’s a diagram of how I’ve set mine up my money management system.
Tips, myths, rules of thumb, and common money mistakes
6 personal finance tips you can start using today
- Annualize your expenses: If you have expenses that you make daily or weekly like going out for lunch at work, start multiplying them out for the whole year. Twenty-five dollars a week doesn’t sound as bad as thirteen hundred dollars a year.
- Focus on the behaviors that drive the result: Go after the things you have control over, like how you shop for groceries. Don’t antagonize about the things you can’t, like the stock market or politics.
- Purchase daily consumable in bulk: You know you’re going to use toothpaste or shampoo, so buy them in bulk when they are on sale and lock in your savings.
- Spend money when it matters: When quality matters, sometimes it pays to buy the more expensive item.
- Keep things simple: Focus on one thing at a time. If you’re in debt, focus on that. If you’re just starting to think about retirement, focus on that. Don’t try to do both at the same time.
- Know your score: Make sure you stay on top of your credit report. Checking your credit score is easy so there is no excuse not to know it.
If you find these to be helpful, you can find even more personal finance tips here.
Dispelling a few common personal finance myths
Money myths can be particularly difficult to debunk because they are passed on in the form of advice by well-meaning parents, friends, and coworkers. Here are a few of the more common personal finance myths to watch out for:
- Myth: Carrying a balance is good for my credit score.
- Reality: Carrying a balance doesn’t help your score, though you do get rated better if you keep a low utilization. You can do this by paying your balance off in full every month.
- Myth: Only rich people need a will.
- Reality: If you have a family that is dependent on you, you need a will. It doesn’t have to be complicated, and they don’t have to be costly. If something happens to you, the last you’d want is your family trying to deal with unnecessary complications during their time of grieving.
- Myth: It’s always smartest to pay off your high-interest debt first, as opposed to paying off your smallest first.
- Reality: This myth discounts the motivation you receive from paying off your smallest debt first. When you first get serious about becoming debt-free, you’ll face an uphill battle for a while. These small wins can be crucial for you keeping your spirits and motivation up.
Stop making these money mistakes
When it comes to our finances, we’ve all made money mistakes. That’s only a problem when you don’t learn from them. Here are some of the more commons ones.
- Trying to time the market: Most of use are not that financially savvy, so trying to time the market is a quick way to lose big money.
- Borrowing from your 401(k): When you borrow from your 401k, you lose out on the gains it would have had to stay in the market. These loans also become due very shortly after leaving your employer. That could mean making a bad situation like losing your job even worse.
- Not discussing your finances before marriage: This is the person you are going to share the rest of your life with. Why would you not want all of your cards on the table?
- Not building an emergency fund: Your emergency fund is your stop-gap from disaster. Without one, you could easily find your troubles start compounding.
- Lending money to the family: If a family member needs money, and you have the desire and ability to help them, make it a gift, not a loan. Money can ruin relationships quick.
Note: When working on money issues it sometimes helps to get an outside perspective from a financial coach. A financial coach is an objective advisor who helps you establish healthy money habit.
Personal finance rules of thumb to remember
Rules of thumb are a great way to help you make decisions easier, as they enable you to quickly assess a situation, and determine if you are at least in the ballpark. Below are a few of the more commons ones.
- For investing: You can determine the optimal asset mix for your investment portfolio by subtracting your age from 120. The number left over is what % should be invested in stocks while the rest is invested in bonds.
- When buying a home: Your housing expenses shouldn’t exceed 25% of your monthly take-home pay, or you may find yourself house poor!
- When budgeting: The 50-30-20 budget rules give you a great way to determine how much you be spending by allocating 50% to “needs”, 30% to “wants”, and 20% to “savings”.
Favorite Personal Finance and Self Help Books
Below are some of my favorite books about personal finance and self-improvement. If you’re still looking for more options, I’d highly recommend checking out Markin Blog’s list of top 200 business books. The list has some great reads.
- The Total Money Makeover – by Dave Ramsey
- The Millionaire Next Door: The Surprising Secrets of America’s Wealthy by Thomas Stanley and William Danko
- The Intelligent Investor: The Definitive Book on Value Investing by Benjamin Graham and Jason Zweig
- Principles: Life and Work by Ray Dalio
- The 7 Habits of Highly Effective People: Powerful Lessons in Personal Change by Stephen Covey
Personal finance blogs, podcasts, and subreddits
- Mr. Money Mustache: Inspiring and informative stories about Mr. Money Mustache journey to financial independence
- Financial Mentor: One of the more detailed blogs out there with exceptional content about saving and investing
- Budgets Are Sexy | Where Personal Finance Nerds are Cool: A very entertaining and humorous take on personal finance
- Dave Ramsey: His approach may not be for everyone, but you can’t say it doesn’t work
- /r/personalfinance: This subreddit on Reddit is filled with tons of super knowledgeable people, who are very open to offering help if you need it. Just make sure you pay attention to the rules and culture of the board.